Borrowing to buy equity is back

Stocks such as Telstra and the big banks are yielding 5 to 6 per cent, making the use of leverage an almost self-funding pure capital gains play.
Photo: Tanya Lake

by
Brendan Swift

Leverage has the potential to turbo-charge investment returns. It also has the potential to destroy them – a scen­ario many investors encountered in the wake of the global financial crisis.

But with the local sharemarket trading at five-year highs, wary investors are once again beginning to consider adding some leverage to their portfolios, although the strategies differ markedly to the bullish approaches that dominated the industry before the crisis.

“It’s certainly a fair bit smaller than it was five years ago, but in actual fact in the last three to six months we have seen some growth," says
Brian Phelps
, CommSec general manager of retail distribution.

“It’s a combination of some new people coming in and getting into gearing and some old people reviving their strategy, which had been down back to zero. Certainly our volumes have picked up: we’re writing 50 new margin loans a week at the moment, which is close to double where we were six months ago."

It is a promising sign for the industry, although it remains a small uptick in momentum and the shift has yet to show in the Reserve Bank of Australia’s figures. In June, the total margin lending market had shrunk to $12.04 billion, less than one-third of its $41.59 billion peak in December 2007. The ongoing fall is not just a shift in market value – the number of margin loan accounts stood at 176,000 in June, representing 14 consecutive quarterly declines.

However, the S&P/ASX 200 has climbed almost 6 per cent since then, giving investors a shot of confidence, according to industry players.

The chief market strategist at IG,
Chris Weston
, says he personally likes to invest when markets are moving.

“I want to be leveraged to a stock, or currency, commodity – index of bonds for that matter – when that stock is in motion. A stock in motion generally stays in motion until we get the exit signal,’’ he says. “I add in a stringent risk and money management strategy, which means I have a plan, which separates a trader from a gambler."

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Increased momentum

Other industry figures note the rise in activity. “There’s momentum there," Bell Direct chief executive officer
Arnie Selvarajah
says. “We’re not anywhere near where we were in 2007, naturally, but we’ve definitely seen an increase and a run-up."

Loan-to-valuation (LVR) ratios still remained at 30 per cent to 32 per cent, well below the 60 per cent range common before the GFC. “That’s giving them the headroom for capital depreciation on any of these stocks."

Nonetheless, Bell Direct says it posted a 200 per cent increase in trading volumes in the September quarter on a year earlier and a 240 per cent increase by value. Investors are still largely interested in higher-yielding blue-chip stocks, often overlaying leverage to make their margin loans close to self-funding. “There’s a change in the mix. Trading used to be across the board but now it’s in the banks,
Woolies
,
Telstra
,
Newcrest
– good dividend-yielding stocks."

At the other end of the spectrum, CFD clients – who tend to be traders rather than long-term investors – are using the highly leveraged investment vehicles to hedge stocks like the major banks and resource stocks amid volatile markets, according to Saxo Capital Markets head of sales
Stephen Luu
.

“We will lend the physical stock to the investor and they will sell short on that and hold that short position as long as they want," he says.

Nonetheless, it will still take a sustained run for the scars of the GFC to heal while the investment outlook remains clouded. Despite the sharemarket rally, fiscal 2013 was the second worst year of the past decade (after the 2009 global recession) for growth in commodity prices, employment ­(measured by hours worked) and ­discretionary consumer spending, according to Deutsche Bank analysts.

Corporate earnings were flat in the June half although that was still the best result in two years. A net 20 per cent of ASX200 companies announced earnings downgrades compared to 30 per cent to 40 per cent in recent years, which has historically been consistent with moderate earnings growth, according to Deutsche Bank.

Stocks such as Telstra and the big banks are yielding 5 per cent to 6 per cent, making the use of leverage an almost self-funding pure capital gains play, although on some measures the banks are now overvalued.

“Resources account for 21 per cent of the market, a six-year low," according to Deutsche Bank. “In contrast, banks’ share of the market, at 30 per cent, is a 10-year high. Certainly the resources super­cycle looks to be over . . . but equally the supercycle of strong credit growth for banks is over."

The excess dividend yield that banks offer over resources – 2 percentage points – is at a 10-year low.

The preference for high-yielding blue chips is underpinned by relatively low margin loan rates. The average ­variable interest rate is currently 7.7 per cent, according to research house Canstar, although one-off deals can cut that even further.

Home for security

Endeavour Planning Services principal
Geoff Munday
says he still rarely encourages leveraged investing. For those who want it, he prefers that their finance is secured over a home.

“The interest rate is lower and there aren’t any margin calls," he says.

“If someone owns a home and is unable to borrow enough extra to do gearing then I think it’s unlikely they should be gearing at all."

Home loan interest rates average 5.36 per cent; some offers are as low as 4.49 per cent, according to Canstar.

Phelps says CommSec customers are increasingly locking in lower margin-loan fixed interest rates. About 44 per cent of CommSec’s margin-loan book is now fixed and pre-paid – the highest level it has ever reached, as investors have been encouraged by the Reserve Bank of Australia’s ongoing cuts. It is well above the 30 per cent to 35 per cent it has historically recorded.

CommSec has also been encouraging investors to hold more diversified margin loan portfolios – the reward is a 5 per cent increase in their LVR ratios.

“By doing that we’ve increased the number of holdings in portfolios from what looked like four shares pre-GFC to an average of 11 shares in a margin loan portfolio . . . The beauty with that diversity is the chances of getting a margin call are now greatly reduced."

Competition between margin lenders remains robust but is centred less on price than during the halcyon days of the industry, according to Canstar research manager
Mitchell Watson
.

Online trading platforms are increasingly offering extras such as greater charting and fundamental analysis tools. Despite largely operating as a self-directed business for investors, CommSec has introduced one such strategy by offering a specialist port­folio construction service for investors for a one-off fee. Their analysts can build a diversified portfolio for clients, who can also nominate if they want CommSec to reweight it later.

“There were a lot of clients out there who had lost the confidence to make those decisions for themselves and that’s a growing business for us," Phelps says.

That lack of confidence is unlikely to dissipate in the short term, although Bell’s Selvarajah says that if the share market can hold this level until the end of the year, and next year brings a positive reporting season, it could prove the tonic the industry needs.

“People are fatigued with volatility and even though the market is running they’re waiting to see if this is another flash in the pan or is sustainable.

“There’s still a lot of scepticism in the market; there’s still a lot of money on the sidelines, which you’d expect. We are starting to see more cash coming into the industry so people have been getting ready."